Unlocking Co-Investments: Regulatory Convergence and Divergence between SEBI and IFSCA Frameworks

CCL NLUO
Aug 14
6 min read

Updated: Aug 16

Fifth year student at Gujarat National Law University, Gandhinagar

I. Background

The concept of “co-investment” under the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) reflects a tightly defined and structurally regulated mechanism for parallel investments alongside Category I and II Alternative Investment Funds (“AIF”). As per the definition, co-investment refers to an investment made by the manager, sponsor, or investors of such AIFs into the investee companies in which the AIF itself is investing. This formulation reveals two key regulatory principles. It confines the universe of co-investors strictly to those already associated with the AIF and where co-investment is undertaken by investors (as opposed to the manager or sponsor), it must be routed through a Co-Investment Portfolio Manager, as regulated under the SEBI (Portfolio Managers) Regulations, 2020 (“PM Regulations”). The regime thus erects a formal licensing threshold, ensuring that only a registered Co-Investment Portfolio Manager can facilitate such opportunities, and even then, only for the benefit of unitholders of Category I and II AIFs, and only in respect of unlisted securities of investee companies where the AIF has an existing exposure. This layered approach reflects SEBI’s broader regulatory philosophy of maintaining control, transparency, and alignment of interests in co-investment activity within the AIF ecosystem.

II. Structural and Regulatory Constraints of the PMS Route for Co-Investments

The Portfolio Management Services (“PMS”) route, though once considered a viable mechanism for enabling co-investments alongside AIFs, has proven to be structurally inadequate and commercially restrictive. Under the PM Regulations, discretionary portfolio managers are expressly prohibited from investing client funds in unlisted securities. Even in the case of non-discretionary or advisory portfolio managers, such investments are capped at 25% of the client’s assets under management, thereby severely constraining the quantum of capital that can be deployed as co-investment is permissible only in unlisted securities. While some investment managers have explored the investment advisory route to bypass these limitations, this structure lacks the necessary alignment of interest, as the co-investor retains discretion over investment and exit decisions, unlike in the AIF structure where the manager exercises control. Furthermore, obtaining a separate PMS registration imposes regulatory and operational costs, without proportionate commercial benefit. A SEBI working group has highlighted that this added compliance burden undermines the competitiveness of domestic fund managers, particularly when compared to global players who face no such restrictions and can participate in large-ticket deals with ease. Direct co-investments also lead to practical inefficiencies, such as cap table bloating and increased transaction complexity for portfolio companies, which may be required to negotiate with multiple individual investors. Compounding these difficulties, the regulatory framework allows co-investment rights only within the same AIF or another AIF managed by the same investment manager and sponsor, thereby stifling the ability to offer cross-fund opportunities where sponsor entities differ. Collectively, these constraints illustrate the inherent incompatibility of the PMS regime with the evolving needs of the co-investment landscape.

III. SEBI’s Proposed Co-Investment Vehicle Framework

In a move aimed at streamlining and liberalising the co-investment regime for AIFs, SEBI through its consultation paper dated May 9, 2025, has proposed the introduction of a dedicated Co-Investment Vehicle (“CIV”) structure under the existing AIF Regulations. The proposed framework seeks to bridge the gap between regulatory rigidity and market demand by allowing AIFs, specifically Category I and II to launch CIVs as separate schemes within the AIF structure for the purpose of facilitating co-investments in unlisted securities of investee companies. A single CIV may cater to investors from any of the schemes of the main AIF, provided they qualify as Accredited Investors. Operationally, the registration of a CIV would be streamlined through a shelf private placement memorandum (“PPM”) to be annexed to the main AIF’s PPM, with deemed approval if SEBI raises no objections within 30 days of filing. CIVs will be granted separate registration numbers, thereby enabling distinct PANs and simplified tax compliance. A key innovation lies in the launch of a separate CIV scheme for each co-investment, with such schemes being exempted from diversification norms and minimum tenure requirements. Further, there is no sponsor’s capital commitment requirement separately for the CIV. To preserve regulatory integrity, SEBI has clarified that the implementation of CIV schemes will be subject to oversight through standards formulated by the AIF industry’s Standard Setting Forum. The proposed CIV regime represents a calibrated and flexible approach, seeking to remove the frictions that have traditionally constrained co-investment activity under India’s AIF framework.

IV. Unresolved Concerns in SEBI’s Proposed Co-Investment Vehicle Framework

While SEBI’s proposal to introduce a CIV model in lieu of the existing Co-Investment PMS framework marks a progressive shift, several operational and conceptual ambiguities remain. First, although the move away from the Co-Investment PMS Licence is welcome, the CIV model appears constrained by the tenure of the main AIF. Since co-investors must exit alongside the AIF, it raises concerns about forced exits or liquidity mismatches, particularly in cases where the AIF struggles to liquidate its investments upon expiry of its term. The consultation paper is also silent on whether the CIV’s tenure can be extended to match the dissolution period of the main AIF, adding further uncertainty. Another practical concern arises from SEBI’s requirement that the shelf PPM for the CIV be filed at the time of the first co-investment. As many AIFs may not identify co-investment opportunities until later in their investment cycle, this requirement could effectively force all AIFs to prepare and file shelf PPMs at inception, regardless of necessity. Further, the consultation paper does not clarify whether a registration fee will be levied upon the CIV’s approval, adding to cost-related ambiguities. Restricting CIV participation only to Accredited Investors raises questions about proportionality, especially when accreditation was originally intended to allow smaller ticket investments (below INR 1 crore) by sophisticated investors. Imposing this condition for co-investments, where alignment with the AIF is more important than accreditation status may unnecessarily narrow participation.

V. IFSCA’s Circular and Framework on Co-Investment

The International Financial Services Centres Authority (“IFSCA”) has taken a structured approach to facilitating co-investments by fund structures operating in GIFT City. Regulations 29(1) and 41(1) of the IFSCA (Fund Management) Regulations, 2025 (“FM Regulations”) empower Venture Capital Schemes (“VCSs”) and Restricted Schemes, respectively, to undertake co-investments through a designated mechanism. Building on this enabling provision, IFSCA issued a circular on May 21, 2025, outlining the operational framework for the launch of a “Special Scheme” to enable such co-investments. The key feature of this framework is its reliance on a segregated structure, wherein co-investment exposure is routed through a separate scheme constituted under the same fund management entity (“FME”) that manages the existing VCS or Restricted Scheme. The Special Scheme must share the same AIF category classification (Category I, II, or III) as its parent scheme and may be constituted in the form of a company, LLP, or trust. It is structurally tethered to the existing scheme, with the latter mandated to hold at least 25% of the capital of the Special Scheme at all times. The Special Scheme’s tenure is required to be co-terminus with that of the existing scheme, thereby ensuring alignment of investment horizon and exit. Special Scheme is permitted to undertake only a single co-investment and may deploy leverage, provided such leverage falls within the caps outlined in the PPM of the parent scheme. While co-investment participation is open to any eligible person under the FM Regulations (subject to minimum contribution thresholds), banking units in IFSC are required to treat the term sheet, filed within 45 days of the investment, as the constitutional document of the Special Scheme.

VI. SEBI’s CIV Model vs IFSCA’s SPV

The IFSCA’s Special Purpose Vehicle (“SPV”) framework under the Fund Management Regulations provides a more flexible approach to co-investments compared to SEBI’s proposed CIV regime. Under IFSCA's framework, a VCS or Restricted Scheme can launch a Special Scheme that co-invests through an SPV, which may raise funds not only from existing investors but also from any person eligible to invest in the parent scheme. In contrast, SEBI’s existing and proposed frameworks are more restrictive. SEBI AIF Regulations permit co-investments only from investors, managers, or sponsors of Category I or II AIFs, excluding external investors and prohibiting Category III AIFs from offering co-investments. SEBI currently requires a Co-Investment Portfolio Management Services licence under the SEBI PM Regulations to facilitate such co-investments, although its May 9, 2025 consultation paper proposes eliminating this requirement. This distinction highlights IFSCA’s preference for asset-specific structures and broader investor participation, in contrast to SEBI’s consolidated and more tightly regulated CIV model.

VII. Conclusion

While SEBI’s proposed Co-Investment Vehicle marks a step forward from the restrictive PMS model, it remains constrained by regulatory overlaps and operational uncertainties. In contrast, IFSCA’s Special Scheme framework offers greater flexibility, broader investor participation and structural efficiency. As co-investments gain prominence, aligning regulatory design with market realities will be key to fostering a robust investment ecosystem.

Note: This article has been reviewed by Mr. Abhiraj Arora (Partner, Saraf and Partners), at the Tier II Stage.